Does your Contracting and Construction Business need Surety Bonds?
Construction Companies: Do You Really Need Surety Bonds?
If you have a contracting and construction business, you will likely encounter different types of surety bonds during the course of your business operations. While you might have heard about surety bonds, you might not understand what they are or whether you need them for your business. Depending on the state in which you intend to operate your business, you might be required to obtain a contractor surety bond as a condition of licensing. Even if you operate in a state in which contractors are not required to be licensed, you should still check with your local and county governments to see if they require licensing. Here is some information about different types of contractor surety bonds and when they might be required.
Understanding Contractor and Construction Surety Bonds
Many construction companies and contractors think that a construction bond is insurance coverage. However, there are some key differences between construction bonds and insurance policies. Unlike insurance, a construction bond does not protect the holder against liability and instead protects the party requiring the bond and the public against potential misconduct.
Another difference is that construction bonds act as a form of credit while insurance policies do not. Because of this, construction bond applications must go through an underwriting process before they will be approved to determine the level of risk the bond company will face if it agrees to issue a bond.
A contractor or construction bond is an enforceable contract involving the following parties:
• Principal - The contractor or construction company that needs the bond
• Obligee - The entity that requires the bond, which could be a private owner or the local, state, or federal government
• Surety - The bond company that issues the bond as a guarantee the principal will comply with the law will follow ethical practices
If your bond application is approved, you will be asked to enter into an indemnity agreement under which you will agree to indemnify the bond company against any claims that might be filed against your bond. If you commit legal violations or violate your other bond conditions, a bond claim can be filed by the government or a harmed private party. The surety company will pay the claimant on your behalf, but you will have to pay the surety for all amounts paid or face litigation.Many construction companies and contractors think that a construction bond is insurance coverage. However, there are some key differences between construction bonds and insurance policies. Unlike insurance, a construction bond does not protect the holder against liability and instead protects the party requiring the bond and the public against potential misconduct.
Another difference is that construction bonds act as a form of credit while insurance policies do not. Because of this, construction bond applications must go through an underwriting process before they will be approved to determine the level of risk the bond company will face if it agrees to issue a bond.
A contractor or construction bond is an enforceable contract involving the following parties:
• Principal - The contractor or construction company that needs the bond
• Obligee - The entity that requires the bond, which could be a private owner or the local, state, or federal government
• Surety - The bond company that issues the bond as a guarantee the principal will comply with the law will follow ethical practices
If your bond application is approved, you will be asked to enter into an indemnity agreement under which you will agree to indemnify the bond company against any claims that might be filed against your bond. If you commit legal violations or violate your other bond conditions, a bond claim can be filed by the government or a harmed private party. The surety company will pay the claimant on your behalf, but you will have to pay the surety for all amounts paid or face litigation.
Types of Construction Bonds and When They Are Required
There are four main types of construction bonds that you might encounter, including the following:
1. Contractor license bond - This type of bond is required in many states as a license condition. In states in which contractors are not required to be licensed, there still might be municipal or county licensing requirements that also mandate license bonds. Contractor license bonds guarantee the bondholders will comply with the regulations and laws governing the industry.
2. Bid bond - Bid bonds might be required by private project owners before companies can bid on private projects. They are also required for construction companies that want to bid on public projects and serve as a guarantee that the company has the capability of completing the project if its bid is accepted and that it will do so. A claim can be filed against a bid bond if the company awarded the contract fails to accept it.
3. Performance bond - A performance bond guarantees the principal will perform its obligations under its contract. This type of bond is one of two bond types required for construction companies that perform work on federal projects worth $100,000 or more. Private project owners might also require performance bonds to guarantee a contractor will perform according to its contractual obligations.
4. Payment bond - This type of bond guarantees a general contractor will pay its suppliers and subcontractors for the supplies they provide and the work the subcontractors perform on a project. Payment bonds are the second type of bond required by the federal government for work on projects worth $100,000 or more. Private project owners also frequently require payment bonds to guarantee the general contractors will pay as promised to avoid potential mechanics' liens against their property. Finally, subcontractors and suppliers might not agree to perform work on a project unless the general contractor has a payment bond.
Why You Might Want to Get Bonded Even if It's Not Required
There are several reasons why you might want to get bonded even if your state does not require it. Getting different types of construction bonds can help to expand the potential contracts you might be able to bid and perform work on. For example, if you want to bid on federal projects, being bonded might allow you to do so.
Many savvy project owners also will not work with companies and contractors that are not bonded. This is because a bond helps to shift the risk from the project owner to the contractor. Similarly, being bonded also might allow you to attract suppliers and subcontractors to perform work on your projects since they know that they will be paid for their work.
How to Get Construction and Contractor Bonds
You can apply for the bonds you need through a surety company. When you apply, the company might also ask you to submit the following types of documents to support your application:
• Audited financial statements
• Company's legal entity documents
• Organizational structure
• Resumes for each partner
• Profit and loss statements
• Information about past projects handled of similar size
• Reference letters from suppliers and subcontractors
• Bank reference letter
• Asset and liability schedules
• Business and personal tax returns
• Bank account statements
Once you submit your application and supporting documents, your application will be reviewed during the underwriting process. Underwriters consider multiple factors when evaluating your risk. Three of the most important underwriting factors include your business and personal credit, your working capital, and your character. If you have great credit, you will receive a lower quote for the bond premium. This premium is a percentage of the bond amount that you must pay to secure the bond. For example, if you need to purchase a $100,000 bond and receive a premium quote of 1%, you will need to pay $1,000 to secure the bond.
If you have poor credit, your application might be denied, or you might receive a higher quote of up to 15% to secure your bond. Once you pay the premium and sign the indemnity agreement, the bond company will issue a bond to you.
While surety bonds are not required for all contractors and construction businesses, certain types might be required in your state or locality. Other types of bonds, including bid, payment, and performance bonds might be necessary if you want to perform work on public projects or on certain private projects. If you do purchase surety bonds, make sure to comply with all of your bond requirements to maintain your bond and avoid potential claims.